Manguinhos, based in Rio de Janeiro, had been trying to
reduce its tax burden by using securities backed by unpaid
government liabilities purchased at a discount, known locally as
precatorios, a practice the Rio state government was disputing
in court. Shares tumbled after Rio issued an Oct. 15 decree to
expropriate land where Manguinhos operates, saying that was
needed to settle unpaid taxes and for low-income housing.

Chief Executive Officer Paulo Henrique Menezes said
Manguinhos can’t stay in business under the current fuel
policies because state-run Petroleo Brasileiro SA (PETR4) is selling
gasoline below cost to help fight inflation. Petrobras is losing
a record $8 billion this year to maintain the subsidies.

“I don’t use precatorios to make money, I use them as a
survival tool,” Menezes said in a telephone interview. “For
more than 10 years gasoline has been subsidized by the
government and by Petrobras. Petrobras says pretty much every
day that whenever it imports gasoline, it loses money.”

Manguinhos shares were halted in Sao Paulo for a week after
the expropriation decree, and fell 68 percent when trading
resumed on Oct. 23 to 0.27 real, reducing the company’s market
value to 241 million reais ($115 million). While Manguinhos
recovered to 0.34 real at 10:35 a.m. today, the shares have lost
investors 78 percent this year, the worst performance among 29
oil and natural gas companies traded on Latin American
exchanges, according to data compiled by Bloomberg.

‘Oil is Ours’

Manguinhos, which has confidentiality agreements with China
Petrochemical Corp. and Dutch company VTTI BV on a $727 million
farm-oil project, produced 345,308 barrels of refined oil in
September, or 0.6 percent of the country’s total. The company
was founded in 1954 during the “Oil is Ours” government
campaign that also led to the creation of Petrobras in 1953. It
was acquired by Grupo Andrade Magro in 2008.

Manguinhos paid 150 million reais cash in taxes last year,
and is seeking in court to pay 248 million reais using
precatorios, Menezes said. Rio Governor Sergio Cabral says 406
million reais is under dispute, according to a Oct. 15
statement. The company had a second-quarter loss of 95.03
million reais on sales of 476.9 million reais, according to data
compiled by Bloomberg. It hasn’t reported third-quarter
earnings.

‘Fiscal Engineering’

Manguinhos’ efforts to pay taxes with government securities
don’t justify the land seizure, said Adriano Pires, the head of
the Brazilian Center for Infrastructure, a research firm in Rio
de Janeiro.

“The expropriation by the governor from the legal
perspective scares any private investor,” Pires said by
telephone. “Everybody knows Manguinhos can only work and make
money using a kind of fiscal engineering.”

Refining output in Brazil, which was self-sufficient in
crude and gasoline until 2009, hasn’t kept up with surging
consumption as Petrobras faces delays and cost overruns at its
biggest projects. Demand is growing four times faster than the
economy as consumers who are getting access to credit for the
first time buy cars.

Brazil, the world’s largest emerging economy after China,
will expand 4 percent next year after an estimated 1.5 percent
in 2012, according to a central bank survey of economists.

Control Inflation

“Any private investor should be dying to build a refinery
in a country with this demand,” Pires said. “They don’t do so
because there is an economic barrier, which is that the
government forces Petrobras to sell fuel below market prices to
control inflation.”

The expropriation decree was published as Rio police and
the army began entering slums near Manguinhos’s facilities to
reclaim control of areas struck by drug dealing, guns and
violence. Rio will host the 2016 Olympic Games.

“Rio de Janeiro’s government will expropriate all the
Refinaria de Manguinhos area and it will be used for
urbanization and low-income housing projects after the cleaning
of soil,” the government said in an e-mailed response to
Bloomberg questions. “In the area a new planned neighborhood
can be built, with apartments, schools, leisure areas, health
centers, libraries and other public equipment.”

Industrial waste and inadequate soil means the land can’t
be used for low-income housing, CEO Menezes said.

A Petrobras official, who can’t be identified due to the
company’s internal policy, declined to comment on Brazil’s fuel
subsidies when contacted by Bloomberg.

Filed Injunction

Governor Cabral said earlier this year that the state would
use power of eminent domain to seize the building where the
BM&FBovespa SA (BVMF3) exchange is located in Rio and turn it into the
new State Legislative Chamber. The exchange’s shares fell 3.4
percent on April 11 after the announcement. Cabral dropped the
plan after valuations showed the purchase price exceeded
available public funds.

Manguinhos filed an injunction against the governor’s
decree on Nov. 6 at Rio de Janeiro’s Justice Court, arguing the
state government can’t expropriate land owned by the federal
government, according to the court’s website.

The confidentiality agreements signed with Sinopec and VTTI
are to discuss possible partnerships in a project to expand
Manguinhos’ storage and turn its refinery activity into cleaning
pre-salt oil by 2016, according to regulatory filings. The
agreements are suspended until a decision on the expropriation
is made, the CEO said.

“As a citizen I feel safer every day in Rio with the
initiatives to pacify the slums,” Menezes said. “But I have no
safety as a businessman.”